Xiaomi Looked Like It Had Beaten the Old Sales Channels. So Why Did OPPO and vivo Beat Xiaomi This Year? | 2016 Digital Transformation at Big Companies ②

Going fully online — the digital playbook Xiaomi pioneered so brilliantly. We thought it had beaten the traditional channels. It turned out we were wrong.

Big legacy companies are still struggling to reach young consumers — and for the multinationals that once led their industries, the struggle is harder still.

Whether it's brand messaging, products, or services, the path to the consumer is no longer smooth. In 2016, going digital became the defining challenge for companies trying to keep up.

Some chose to ally with internet service providers, holding their market share or even growing — but at the possible cost of direct contact with consumers, as McDonald's has shown.

Others moved themselves online, but often torn about it — luxury brands being a prime example.

Through all of this, established leaders could only watch as new entrants rewrote the rules of the game, while they scrambled to keep up.

Where traditional companies can still take heart is this: before digitalization has fully remade supply chains and corporate structures, the scale and steady demand they built over many years still leave them room to live — even if the chances to fail and recover are running out.

That is why QDaily is launching its year-end 2016 series on digital transformation. Over one month, ten articles will look closely at what big companies gained and lost as they went digital. This is the second.

"What price range are you looking at?" the salesperson in the phone shop asked me.

Before I could answer, she had reached into the OPPO display case and handed me a newly launched flagship, the R9s.

The shop, on Beijing's East Fifth Ring Road, is hard to put a name to: the sign reads China Telecom, China Unicom, and China Mobile all at once; a giant green OPPO balloon arch stands at the entrance, and a vivo mascot as tall as a grown adult waits outside.

I hadn't come to buy a phone, but behind the salesperson a young woman had already bought an OPPO R9s and was signing for it at the counter.

OPPO had just sold one more phone at 2,800 yuan. By the end of September this year it had sold more than 70 million handsets. At the current pace it will pass 100 million for the full year — against just 42.2 million for all of 2015.

According to data from the research firm IDC, the top two sellers in China's phone market are OPPO and vivo, two companies with shared capital roots. Globally, they trail only Samsung, Apple, and Huawei.

By comparison, Xiaomi — riding high just two years ago — is in a grim spot. In 2016 its shipments fell rather than grew, and the line from IDC's second-quarter report, "Xiaomi shipments down 38% year-on-year," became the biggest news of the cycle.

Xiaomi Was Never Just a Company That Sold a Lot of Phones

When Lei Jun held his 2011 press conference to announce that Xiaomi would make phones, few people really believed it. It had plenty of investment but no manufacturing heritage at all, and a brand-new company that became China's largest phone maker in three years was something only Xiaomi managed to do.

The two things most often cited about Xiaomi's innovation — how it sold phones over the internet, and how it cut out the middleman — don't capture what it actually did. Xiaomi's digital overhaul of the phone business went well beyond the internet as a sales channel.

It started with software. Xiaomi shipped a new version of MIUI every week, not just adding features and fixing bugs but keeping a window open for users to submit feedback and ideas for improvement.

By Lei Jun's account, in 2011 MIUI already had 500,000 enthusiasts taking part in its development, and a third of its improvements came from users online. For the Android of that era — clumsy to use and ugly to look at — MIUI was a genuinely pioneering product.

Xiaomi was just as deliberate about how it shipped product. Each week's pre-order count, its social-media numbers, even scalper prices all fed into how many units it ordered from the factory.

Because Xiaomi's phones used the newest chips and components, which were expensive at first, this let it control both the volume and the pace of shipments. By the time it opened full-scale sales, falling chip and materials prices had already widened its margin.

Xiaomi's success became a template that rivals rushed to copy. After 2013, ZTE, Lenovo, and Huawei each set up an "internet sub-brand" to take on Xiaomi in e-commerce and software, and their CEOs were expected to market themselves on Weibo, just as Lei Jun did.

On that foundation, Xiaomi threw itself into the supply chain. From 2011 to 2014 its annual shipments grew from 420,000 units to 60 million — at least tripling every year.

"We spent a very long time solving the whole supply chain, and production could finally scale. Then we hit a ceiling. Supply was no longer the problem, but a channel problem had appeared," Lei Jun said in an interview. "We underestimated how fast the phone market could change. The market gave us less time than we thought."

The "channel problem" Lei Jun meant was, in effect, OPPO and vivo. The two had opened 200,000 branded phone shops in cities and towns across the country, pulling people in with giant inflatable figures, balloon arches, and ads featuring Korean pop stars.

Selling Phones Today Still Comes Down to Brand and Offline Channels

The "less time than we thought" that Lei Jun mentioned comes down to one thing: China's smartphone market has slowed.

People buying their first smartphone are reached more by physical stores and television than by the internet. And the people who bought their first Android phone two years ago are now ready to upgrade.

That is the market OPPO and vivo know best.

Drawing on the capital built up in the Subor and BBK years, OPPO has leaned on celebrity star power going back to the MP3 era. In 2011 it signed Leonardo DiCaprio for the ad for its first phone. This year it signed Yang Mi, Yang Yang, Li Yifeng, and TFBoys all at once.

vivo carried on the advertising blitz it inherited from BBK's electronic-learning-aid years, signing the hottest stars each season — Song Joong-ki among them — and making sure its name appeared on the sponsor list of every big variety show: Happy Camp, Day Day Up, The Voice of China.

Inescapable advertising is only part of it.

After those TV commercials, OPPO and vivo's offline network makes sure a consumer can step out the door and find a dedicated store right away.

No other company in China has matched OPPO and vivo's franchise-and-agency push into smaller cities and towns. Starting in 2013, they spent three years growing from 50,000 stores to more than 200,000.

According to OPPO chief marketing officer Liu Lei, less than 5% of OPPO's sales run through e-commerce sites like Tmall and JD.com; 95% of its phones sell offline. Add vivo, and the two brands' offline share reaches 97%.

Offline selling isn't charity. For a franchisee, pushing OPPO and vivo makes plain financial sense: it pays.

The budget OPPO A31 and R7 now sell for one to two hundred yuan more than the Redmi 2 and Redmi 2A; the OPPO R9 — launched in the same March–April window as the Xiaomi Mi 5 — still carries a premium of roughly 500 yuan.

Across both companies, entry-level phones typically cost one to two hundred yuan more than the Xiaomi equivalents; mid- and high-end models run at least five hundred yuan higher.

That gap lets OPPO and vivo hand more money to the channel. According to China Securities Journal, a salesperson pockets about 100 yuan each time they sell an OPPO phone. It is widely understood that more than 20% of OPPO's revenue flows back to shopkeepers, shop staff, and provincial distributors. Xiaomi doesn't have the gross margin to do any of that.

The result: no matter which phone you ask about in a street-level store, you'll be steered back to OPPO or vivo in the end.

We ran into exactly this in a Dixin Tong store. When we asked about Samsung and Huawei models, the salesperson breezed through their selling points and pivoted back to OPPO and vivo — a well-worn script by now.

"The Huawei P9 camera is a Leica collaboration — but the R9s has a 16-megapixel sensor, so it's higher resolution and the photos come out sharper," one salesperson told me.

The reason OPPO and vivo have so much money to subsidize the channel is that they have built more room into their margins.

"The data we see shows that from 2014 to now, the average price of a smartphone in China has risen about 30%. That figure covers both iPhone and Android, so once you strip out the pricier iPhone, the price growth for Android phones looks even sharper," Gartner analyst CK Lu told QDaily.

Behind this, of course, is the upgrade cycle Lei Jun himself pointed to.

"OPPO and vivo's success this year comes mainly from the arrival of the upgrade market. After their first phone, people no longer just chase the lowest price — they weigh overall quality, after-sales service, brand, and experience. Consumer attitudes are changing. OPPO and vivo have worked the offline channel for years, which puts them in a better position to catch and adapt to that shift quickly," CK Lu said.

But raising prices also lets you put more money back into the channel and sell still more phones — a good cycle that OPPO and vivo have been able to ride.

At least the numbers back it up so far. QuestMobile data shows OPPO held on to 45% of upgrading users and vivo to about 34% — first and second, respectively, among Android brands.

Lei Jun has admitted he was late to move offline.

"(OPPO and vivo) are two excellent companies, but I think Xiaomi runs on a completely different model from theirs, with a completely different philosophy. We won't copy them at all, because their model is the reverse of ours."

For all that, Xiaomi has already started moving. The Mi 5s and Mi Note 2 both launched at prices several hundred yuan above their predecessors. At the same time, Xiaomi began advertising, signed Tony Leung as a brand ambassador, and announced a strategic partnership with Suning, launching new models there first.

The pivot won't be easy. Even at Suning, Xiaomi's strategic partner, it is still OPPO and vivo that hold the best counters. After two OPPO salespeople rattled off the R9s specs at us for five minutes, they pulled out the clincher:

"That 3,200-yuan sticker is really only 2,799 yuan here at Suning. Buy now and you get a gift bundle: lifetime free screen protectors, warranty… and a little bag."

Stalled Technology Innovation Is Another Big Factor

Over the past six or seven years, the smartphone as a product has seen no real breakthroughs — much as walking into any phone shop today and looking around shows nothing but large and small "mini tablets."

Phones in the same price range don't differ much on hardware; and as Android itself has matured and every custom skin has filled in the must-have features, what's left to innovate in software has grown ever more incremental, and ever rarer.

So the software edge an internet company like Xiaomi once held is gone. Watching sales slide with no bottom in sight, Lei Jun used July's Davos forum to set a new direction for Xiaomi: become the technology world's MUJI.

These "MUJI" products are the ecosystem companies Xiaomi has invested in or partnered with, which together form the "Mijia" brand:

• March 29: Mijia rice cooker, 999 yuan
• April 12: Mijia Xiaobai smart security camera, 399 yuan
• May 11: Mijia iHealth blood-pressure monitor, 399 yuan
• May 27: Mijia LED desk lamp, 169 yuan
• June 14: Mijia constant-temperature electric kettle, 199 yuan
• June 23: Mijia Qiji electric-assist folding bike, 2,999 yuan
• August 31: Mijia robot vacuum, 1,699 yuan

But Xiaomi fans won't necessarily buy these "MUJI" products — at least not as a given.

The Overseas Markets Everyone Wants Also Lean More on Offline Than Online

As growth in China's phone market slows, every maker is looking abroad for new ground.

Huawei has been the most successful at it. Over the past two years, close to half of Huawei's phone sales have come from overseas, and it is the only Chinese company to make a real mark in the high-income markets of Western Europe.

Most companies have set their sights on nearby India and Southeast Asia. OPPO has already taken 10% of the Southeast Asian market, breaking into the top ten in Indonesia, Malaysia, Singapore, Thailand, and Vietnam.

This year, every Chinese phone maker you can think of went to India to build factories — Xiaomi, Huawei, OPPO, OnePlus, Gionee, Asus — though most of those "factories" are contract deals with assemblers like Foxconn and Flextronics, meant to cut costs and get around India's import tariffs on electronics.

In India, Xiaomi has tried to sell phones the OPPO-and-vivo way. Since announcing its entry into the Indian market in 2014, Xiaomi has operated there no differently from a conventional phone maker — even though it set up an official India website, it adjusted quickly, buying newspaper ad space, building out offline distribution, and in some ways pushing harder than it does at home.

In April it struck a partnership with the distributor Redington; in July it joined the online distributor Just Buy Live and Foxconn's InnoComm to build 5,000 physical stores. Hugo Barra, the Xiaomi vice president running overseas operations, said the eventual target is 10,000 stores — ten times the number of Mijia stores in China.

But abroad, Xiaomi faces the same old domestic rivals: OPPO, vivo, Huawei, and more.

OPPO's overseas PR head, Tan Hongtao, said the company is treating India as another China market and will spend 100 million yuan on its assembly plant there. This year it also put 80 million yuan into advertising in India alone, signing Bollywood star Hrithik Roshan and fashion figure Sonam Kapoor as brand ambassadors.

vivo has been busy in India too: beyond title-sponsoring the Indian Premier League (IPL) cricket tournament, a favorite with Indian viewers, it plans to spend another 100 million yuan on advertising. Huawei's overseas advertising in various regions is starting to look more and more like both companies' — Scarlett Johansson in China, and David Beckham's son Brooklyn in the United States.

In the end, just as in China, it comes back to brand and offline.